Not Just Another Day in the Park

Theme parks are normally a place to enjoy a nice day out with your friends or family. However, in mainland China, theme parks may soon turn into a battleground. Recently, Wang Jianlin who heads the Wanda Group, a conglomerate that has opened several amusement parks across China over the last few years, warned Disney about its theme park operations in China. On China Central Television in May, he said: “Disney really shouldn’t have entered the mainland.” Aiming to surpass Disney as the largest tourism enterprise by 2020, Wang went on to threaten: “We will make Disney’s China venture unprofitable in the next 10 to 20 years.”

Thinking though what Wanda needs to do to make this strategy work, I am skeptical. To make Disney’s theme parks unprofitable requires that Wanda reduce the number of attendees to Disney’s parks, reduce Disney’s ticket prices, or both. For Wanda to accomplish any of these requires them to either provide higher quality or price lower than Disney. Let’s examine each of these starting with quality.

Economists distinguish two types of quality differences between firms: horizontal and vertical. A vertical quality difference means that most people would agree that one firm’s quality is better than another regardless of their individual tastes. For example, almost everyone would agree that a faster Internet connection is better than a slower one. A horizontal quality difference means that some people prefer one firm’s product more than another and others the opposite. For example, some people prefer the taste of Coke while others prefer that of Pepsi but there is no general agreement on which is superior to the other.

Theme parks are more horizontally than vertically differentiated. While Disney offers Mickey Mouse, Snow White and Winnie the Pooh[1]; Wanda offers interactive battleship rides, an ancient tea road, and Ha’erbin local culture. Therefore, some people prefer to go to a Disney park, others to a Wanda park, and many would like to attend both if possible. If I am right about this then it will be difficult for Wanda to significantly lower attendance at Disney’s parks through quality differences.

This leaves price as a weapon for lowering Disney’s profits. Unlike quality differences this is more likely to succeed. Even though the firms’ parks are horizontally differentiated a big enough price difference is likely to lead some people to abandon Disney’s parks for Wanda’s. Supposing this works, the question then is what Wanda will accomplish by doing this.

If Disney sticks around this is not good for Wanda. It will lower Disney’s profits but only at the expense of lowering its own profits. And given the horizontal differentiation in the industry Wanda is likely to have to lower its price a lot to lure a significant number of attendees away from Disney’s parks. Also Wang is claiming they will do this over the next 10 to 20 years. That is a long time to endure these lower profits.

Presumably Wang’s endgame is to drive Disney out of the industry after which Wanda can increase its prices since its parks will then face less competition. The question then is how likely is Disney to leave? To answer this it is useful to apply the concept of “sunk costs”. Sunk costs are costs that a firm cannot recover if it shuts down its operations. For example, once a railroad track has been laid the cost of it is mostly sunk. The railroad ties themselves are useless for anything else but scrap and the land is worth little because it comprises such a narrow corridor.[2] If sunk costs are high a firm is unlikely to shut down its operations because as long as it can earn enough money to cover its ongoing costs it will continue operating. The sunk costs are unavoidable regardless of whether the firm shuts down or not.

So how large are Disney’s sunk costs? As an example, Disney spent $5.5 billion dollars building its Shanghai Disney resort before it even opened. Most of this investment is probably unrecoverable if it later shuts down. Except for the land on which the resort resides, most of the other costs are sunk. The rides and buildings are so specialized that they are useful only as a theme park. This means that Disney will not go easily. As long as Disney can charge a price high enough to cover its ongoing costs of running the park it will likely hang in there.

All this leads me to think there is a much better strategy for Wanda—try to get along with Disney. Rather than fighting them on price maintain the horizontal differentiation of the parks and try to charge reasonably high prices. Disney has no reason to fight this and the end result would be that those who like Wanda parks will tolerate its higher prices, those who like Disney’s parks will tolerate its higher prices, and those who like both will attend both.

To make a theme park character analogy, I would recommend that Wanda pursue a strategy more in keeping with the overly-polite “Goofy Gophers” than “Wile E. Coyote’s” endless and ultimately fruitless attempts to catch the “Road Runner.”

[1] Although at one point there were allegations that the Wanda characters were too much like Disney characters.

[2] In the U.S. some former rail lines have been converted to walking paths under efforts called “rails to trails” but profit-making uses are scarce.

About Brian Viard

Prof Brian Viard is Associate Professor of Strategy and Economics at Cheung Kong Graduate School of Business. He explores the workings of economics in everyday life and business in China through this column.

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